Economic Watch WHY WE CAN'T LIVE WITHOUT ECONOMISTS
GARY S. BECKER

02/02/1987
Business Week
Pg. 20
Copyright 1987 McGraw-Hill, Inc.

Jokes about the shortcomings of economists are endless. The reason is simple. Both business and government need guidance that only economists can provide, especially forecasts of inflation, aggregate employment and output, and of the effects of tax reform, the federal deficits, and other events that affect the future of the economy. Yet--and this is the source of the jokes and criticism--such predictions are often unreliable. The fact is economists are poor at forecasting short-term changes in the economy.

The recent annual meeting of the American Economic Assn. in New Orleans spotlighted the current state of thinking about the profession's limitations, as well as its achievements. The 6,000 members in attendance could choose from over 100 sessions on many subjects. The meetings on macroeconomics, which deals with inflation and changes in aggregate output and employment in an economy, were the most popular, whether the speakers holding forth were Keynesians, monetarists, rational expectationists, or supply siders.

The extent of the disagreements at these sessions testifies to the conflicting views within macroeconomics. In one panel, four excellent economists analyzed the effects of federal deficits on the economy. Their conclusions ranged from predictions that there would be rather little effect to moderately adverse effects to sizable adverse effects. Sadly, the available evidence is too weak to permit a choice among these views. My own opinion, and I am not a specialist in macroeconomics, is that even large deficits do not damage an economy if they last for only a few years. UNSUNG SPECIALTY. My field is microeconomics. This discipline studies how consumers, workers, and other participants in economic activities decide such economic issues as what to buy, how much to save, where to work, and how many hours to work at any given wage. Although microeconomics stirs its share of controversy, economists generally agree--and they have substantial evidence to support their view--about its basic assumption: that economic participants make rational choices. Microeconomics attracts less attention from the media than does macroeconomics, yet it has had stunning practical successes during the past decade.

Although these successes include the industry deregulation movement and several other issues, I will concentrate on two subjects popular at the recent AEA meeting: finance and law.

A revolution in thinking initiated during the 1950s replaced ad hoc precepts about financial issues with models of rational choice. One model, for example, explains how investors determine the type of securities to hold in their portfolios by analyzing the trade-offs between expected return and risk. Related models are used to analyze the effect of company debt on prices of common stock and to guide the use of options and arbitrage.

As a result of such applications, the intellectual foundations of finance have been recast into a microeconomic framework. This approach now dominates the teaching of finance. It also permeates mutual fund management and the behavior of commercial and investment banks and other financial intermediaries. LEGAL INFLUENCE. The law and economics movement began with academic economists and lawyers who believed that economic analysis could greatly improve antitrust policy. It has spread to all other legal fields and has also infiltrated legal practice. Microeconomic analysis in legal decisions has grown rapidly partly because scholars of the law and economics, such as Robert H. Bork, Frank H. Easterbrook, and Richard A. Posner, moved from academia to the bench.

Microeconomics has also achieved great success in altering thinking about criminal law. Claims that criminals cannot be deterred by punishment because they are mentally sick or alienated from society dominated thinking about criminal justice in the 1950s and 1960s. The microeconomic approach assumes that, on the contrary, most criminals make rational choices given their circumstances. This view has had an enormous influence on public policy and judicial decision-making during the past decade. Hostile reaction to judges and legislators considered soft on crime and the revival of capital punishment are part of the evidence that the microeconomic interpretation of criminal behavior has won many followers.

This discussion explains why economists are prominent in public policy debate and in analysis of business decisions. My attention to the important practical and theoretical achievements of microeconomics should not suggest that macroeconomics remains stagnant. The large disagreements among macroeconomists today is far healthier than the agreement in the 1940s and 1950s on an unrealistic model of the economy.

Despite economics' accomplishments, the public demands more from it, especially from macroeconomics, than it can deliver at present. This conflict between what the public wants and what economists can deliver explains why economists continue to face ridicule at the same time they are courted by government, business, and the media.

They may disagree on short-term trends, but economists have had stunning practical successes over the past decade

-- GARY S. BECKER IS UNIVERSITY PROFESSOR OF ECONOMICS AND SOCIOLOGY AT THE UNIVERSITY OF CHICAGO